Is It Time to Sell Dividend ETFs?

From Zacks: Dividend ETFs across world have had a stellar-to-decent show so far this year with volatility rearing its ugly head occasionally and interest rates staying low in the developed world on risk-off trade sentiments.

Global growth issues, no Fed rate hike this year after the liftoff in December, ultra-easy monetary policies in the Euro zone and Japan, Brexit, the upcoming U.S. election and volatility in oil prices led investors to settle on this relatively safe investing corner.

Not that markets did not hit highs, but they were unable to mellow investors’ lure for steady current income. Below 2% yield in the benchmark U.S. Treasuries for the most part of 2016 seems to be doing this trick. Investors should note that yields on the benchmark 10-year Treasury note plunged to record lows in July.

However, the winning trend lately lost momentum. A barrage of upbeat U.S. economic indicators, renewed talks about a Fed rate hike this year and the ECB’s taper talks recently pushed up the Treasury bond yields higher. Investors wagered on a quick end to a rock bottom interest rate era in the developed world. As a result, yield on the 10-year U.S. Treasury note increased 16 bps to 1.72% in the last four days (as of October 5, 2016) (read: 6 ETF Areas to Watch as Fed Meeting Starts).

As soon as Treasury bond yields stared to rise, investors started dumping dividend paying equities. High-dividend paying utilities shares dropped for nine days in a row on October 5, representing “its longest losing streak since 2002.” But what are the other reasons that hurt dividend investing lately?

Rich Valuation: After such a steep way-up in the earlier part of the year, most high-dividend paying equites are now guilty of stretched valuation. As per Blackrock, “valuations among global high-yielding stocks were at their highest levels in more than a decade in June.” So, in a difficult investing time, a correction in dividend ETFs seems reasonable.

Slowing Dividend Hikes: Dividend net increases for U.S. domestic stocks slowed to $6.0 billion in 3Q16 from $7.3 billion in 2Q16 and $10 billion in 3Q15. For the trailing 12 months ending September 2016, net rise in dividends dropped 55.9% to $20.8 billion.

Higher Dividend Cuts: Dividend cuts over the 12-month period ending September 2016 increased 97.9% to $21.1 billion compared with what we have seen in the 12-month period ending September 2015. The energy sector resorted to a solid 39% of total dividend cuts in Q3.

Drop in Yields: Dividend yields too slipped in Q3 with large-caps at 2.12% (down from the 2.17% in Q2), mid-caps at 1.64 (1.68% in Q2) and small-caps at 1.31% (1.38% in Q2).

Fading Cash Cushion: Cash conditions of U.S. companies haven’t been too good lately. Burdened by a year-and-a-half of flagging profits and expenses on activities like buybacks and dividends, U.S. companies have now started to see leakage in its huge cash loads, as per Bloomberg. Earnings recession for six quarters in a row was responsible for this cash exhaustion. This weakness may also result in lower dividend hikes in the days to come (read: 3 ETFs & Stocks to Defy Dwindling Cash at U.S. Companies).

What Lies Ahead?

With lofty valuations in dividend stocks plus deteriorating fundamentals, some sell-offs seem inevitable. Still, investors desperate for dividend investing can have a look at a few low P/E or undervalued dividend ETFs. Also, benchmark-beating high-yielding products may also come to investors’ rescue given the rising rate concerns.

As per an analyst at TCW Group, “the valuations for health care are very attractive, particularly for pharmaceutical companies which have really juicy yields.” So, investors – not worried about price gouging issues in the pharma space – can have a look at PJP (read: Will a Clinton Presidency Spell Doom for Pharma ETFs?).

Since rising rates are good for financial stocks, the fund can come across as a good bet, especially given that its P/E is 9 times compared with S&P 500-based (SPY – ETF report) ’s P/E of 17.73 times (read: 4 Sector ETFs at a Bargain).

As emerging market (EM) equities are much better positioned and well insulated from Fed rate hike fears this time around than these were in 2013, a look at this high dividend EM ETF makes sense. EDIV has a P/E of 11.1 times.

The product comprises 60 securities with the highest average quarterly dividend yield over the past 12 months, which are then reweighted according to the revenues of the company. The fund is heavy on consumer cyclical (28.6%), utilities (16.93%), energy (16.55%) and communications (14.86%). RDIV has a P/E of 11.22 times.